The Effect Of Interest Rates On Commercial Real Estate Prices: The Case Of Commercial Leases In Nairobi County

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Abstract

The changes in interest rates do have a diverse effect across the economic spectrum in any country. The sectorial and economy wide effects of interest rates may ultimately be reflected in the commercial rent. The objective of this research was to examine how changes in interest rates (represented by the average lending rate by the Central Bank of Kenya) and Commercial rent (represented by the quarterly average rent per square foot in Nairobi‘s commercial zones) are related to each other.
The study explored level of interest rates and property prices in Kenya and around the world. A review of the relationship between property prices and interest rates was also performed using empirically supported findings of various studies, locally and around the world. The study finally investigated the relationship between interest rates in Kenya and the commercial rent per square foot in the commercial zones of Nairobi County. To establish the relationship, data on commercial rent was collected using 50 commercial leases (within the commercial zones of Nairobi County) between January 2007 and December 2013. Using this data, we determined the average rent per square foot for each quarter in this period. We obtained the interest rate per quarter from the CBK website for the same period.
The research used Toda and Yamamoto (1995) method to determine the relationship between commercial rent and interest rates. This method is applicable ―whether the Vector Auto Regression (VAR) may be stationary (around a deterministic trend), integrated of an arbitrary order, or co-integrated of an arbitrary order‖ (Toda and Yamamoto, 1995). The results therefore indicated that there was causal relationship
between interest rate and commercial rent albeit in one direction share price i.e Movement in commercial Rent causes changes in interest. There was however no evidence suggesting that movement in interest causes changes in commercial rent. As regards the sign of causality, positive causality exists in one direction. These findings are consistent with a Knight Frank report in 2013 which indicated that commercial real estate may be headed for an oversupply in Kenya due to the high returns from commercial real estate in recent times. The fact that rent does not respond to interest rate movement may be due to the rigid structure of commercial lease legislation in Kenya. The findings are however inconsistent with those of Conerly (2013) and Olick (2013) who concluded that real estate prices are responsive to changes in interest. A key recommendation of the study is a legislative change that should allow commercial leases to respond to economic stimuli such as interest rates.